In Rieckborn v. Velti plc, 2015 WL 468329 (N.D. Cal. Feb. 3, 2015) (Orrick, J.), the United States District Court for the Northern District of California clarified the scope of the judgment reduction provision that is found in almost all class action settlement agreements by holding that nonsettling defendants are entitled to a judgment reduction measured by the proportion of fault of all settling defendants, not just a dollarfor-dollar judgment reduction, on all settled claims under the Securities Act of 1933 (the “Securities Act”). In so holding, the court handed a major victory to nonsettling defendants in actions under the Securities Act by granting them a favorable form of judgment reduction on claims not explicitly covered by the Private Securities Litigation Reform Act of 1995 (the “PSLRA”). The court’s opinion also makes clear that bar orders cannot preclude “independent claims” and that bar orders must be “mutual,” thereby giving guidance to the drafters of class action settlement agreements. Background In securities class actions with many defendants, a so-called “bar order” can encourage partial settlements by ensuring that the settling defendants are protected from contribution, indemnification and other similar claims and that nonsettling defendants will pay no more than their proportionate share of liability. Federal courts for many years thus have adopted such bar orders. The PSLRA codified this authority by mandating that courts approving securities class action settlements enter bar orders against future claims for contribution against the settling parties. In particular, the PSLRA provides that “[a] covered person who settles any private action at any time before final verdict or judgment shall be discharged from all claims for contribution brought by other persons” and that, to that end, a court must enter an order barring “all future claims for contribution arising out of the action: (i) by any person against the settling covered person; and (ii) by the settling covered person against any person, other than a person whose liability has been extinguished by the settlement of the settling covered person.” 15 U.S.C. § 78u–4(f)(7)(A). The PSLRA also provides for a judgment reduction for nonsettling defendants in the event of partial settlement between the plaintiffs and certain other defendants. In particular, the statute provides that where a “covered person” settles before a final verdict or judgment, the subsequent verdict or judgment is reduced by the greater of: “(i) an amount that corresponds to the percentage of responsibility of that covered person; or (ii) the amount paid to the plaintiff by that covered person.” 15 U.S.C. § 78u– 4(f)(7)(B). For both the bar order provision and the judgment reduction provision, the PSLRA defines a “covered person” as “(i) a defendant in any private action arising under [the Securities Exchange Act of 1934 (the ‘Exchange Act’)];” or “(ii) a defendant in any private action arising under [Section 11 of the Securities Act], who is an outside director of the issuer of the securities that are the subject of the action.” 15 U.S.C. § 78u–4(f)(10)(C) (emphasis added). As a result of the definition of “covered person,” the PSLRA leaves unclear whether nonsettling defendants are entitled to a judgment reduction when defendants other than outside directors settle Securities Act claims. District Court’s Decision The plaintiffs in Rieckborn were investors in a company called Velti plc (“Velti”). They asserted Exchange Act and Securities Act claims against Velti as well as several of its officers and directors, its accounting firm, and the underwriters of the securities purchased by the plaintiffs. Velti and four of its officers and directors later agreed to a settlement with the plaintiffs. The settlement did not include all of the defendants. In particular, Velti’s accounting firm and underwriters declined to participate in the settlement, and five of Velti’s officers and directors located overseas had never been served and thus were never part of the case. The partial settlement provided for the creation of a settlement fund to be financed exclusively by Velti’s insurance policies. The nonsettling defendants objected to the settlement on several grounds relating to the proposed judgment reduction provision and the proposed bar order. Judgment Reduction The nonsettling defendants raised objections to the proposed judgment reduction provision of the bar order. First, they contended that the proposed settlement was unacceptably vague as to the formula that would be used to calculate any judgment reduction they would receive. The plaintiffs disagreed, arguing that the settlement was sufficiently clear as to the judgment reduction formula because it stated that any future judgment would be “reduced in accordance with applicable law.” Second, the nonsettling defendants contended that the settlement failed to make clear that they would be entitled to a judgment reduction measured by the proportionate liability attributable to other defendants on all Securities Act claims (“uncovered” claims) as opposed to just Securities Act claims settled by outside directors. The plaintiffs again disagreed, arguing that the nonsettling defendants were not entitled to a judgment reduction measured by the proportionate liability attributable to other defendants on all settled Securities Act claims but rather that they were only entitled to a dollar-for-dollar judgment reduction on uncovered claims. The Rieckborn court agreed with the nonsettling defendants on both counts. First, the court held that the judgment reduction provision in the settlement had to state with greater clarity how settled Securities Act claims would later reduce any judgment against the nonsettling defendants. The court reasoned that because the case before it involved both Exchange Act and Securities Act claims, it was not clear what the “applicable law” would be to decide the amount of the judgment reduction. The court also observed that there was “considerable ambiguity regarding what setoff formula applie[d] to uncovered Securities Act claims,” and that the difference between a judgment reduction under the proportionate fault rule and the dollar-for-dollar rule was significant because the amount of the settlement was “severely constricted by Velti’s bankruptcy and the . . . limited financial resources” of Velti’s officers and directors. Rieckborn, 2015 WL 468329, at *17. Given these circumstances, the court concluded that it was only fair for the nonsettling defendants to “know the nature of their risk now, not on the eve of trial.” Id. Second, the court held that the nonsettling defendants were entitled to a judgment reduction measured by the proportionate liability attributable to other defendants under the PSLRA on uncovered Securities Act claims, not just a dollar-for-dollar judgment reduction. In so holding, the court was not convinced by the plaintiffs’ reliance on the plain language of the PSLRA, which in their view limited judgment reduction measured by the proportionate liability attributable to other defendants to settled Securities Act claims against outside directors and excluded settled Securities Act claims against other defendants. The Rieckborn court held that the PSLRA had not displaced a court’s federal common law authority to tailor an appropriate bar order to the circumstances of a given case, and noted that pre-PSLRA law in the Ninth Circuit called for a judgment reduction in Securities Act cases identical to that adopted by the PSLRA. The court also noted that the plaintiffs had failed to cite any authority “holding that different setoff formulas should apply to Exchange Act and Securities Act claims pending in the same action.” Rieckborn, 2015 WL 468329, at *19. In sum, the court reasoned that it was only fair to limit nonsettling defendants’ future liability based on the liability attributable to other defendants. As the court explained, “Given that the settling plaintiff’s level of control over the settlement outcome is, in most cases, exponentially greater than the nonsettling defendant’s, it is appropriate to place this risk on the plaintiff, who then has a financial incentive to make sure that each defendant pays his respective share of damages.” Id. (internal quotation marks omitted). Accordingly, the court stated that it would revise the settlement to make clear that all claims, including all Securities Act claims against the nonsettling defendants, would be entitled to a judgment reduction measured by the proportionate liability attributable to other defendants. Other Terms of the Bar Order With respect to the proposed bar order, the nonsettling defendants raised two noteworthy objections.First, one of the nonsettling defendants, Velti’s outside accounting firm, asserted that the bar order could be interpreted to bar “independent claims,” or future claims they may wish to assert having nothing to do with the released claims. Such a bar was impermissible, they contended, because “bar orders may only bar claims for contribution and indemnity and claims where the injury is the nonsettling defendant’s liability to the plaintiff.” Rieckborn, 2015 WL 468329, at *14 (quotation marks omitted). The accounting firm thus asked the court to revise the proposed bar order to make clear that it did not preclude the nonsettling defendants from asserting claims against any released party to recover amounts other than amounts any released party was required to pay under the settlement. The district court agreed that the bar order should not preclude independent claims but concluded that the language in the proposed bar order did not do so. The district court contrasted that language with inappropriately broad bar orders that precluded future claims “arising out of or related to any of the transactions or occurrences alleged.” Id. (quotation marks and ellipses omitted). Because the court was satisfied that the bar order did not preclude independent claims, it concluded that the accounting firm’s proposed revisions to the bar order were unnecessary. Second, the nonsettling defendants argued that the bar order had to be “mutual,” such that “any party who [was] protected against claims of contribution and indemnification [would] also be prohibited from asserting such claims.” Id. They pointed to Section 78u–4(f)(7)(A) of the PSLRA, which, as the settling defendants did not dispute, mandates that the contribution bar be mutual. The district court agreed. It observed that while the bar order prohibited contribution and indemnification claims against released parties, it did not prohibit such claims by released parties against third parties. As such, the court held that the bar order had to be revised to clarify that it would prohibit claims both by and against released parties. Analysis The Rieckborn decision is mainly important with respect to judgment reduction provisions, and not only because it reconfirms the ability of courts to craft appropriate bar orders and judgment reduction provisions under their federal common law authority despite the passage of the PSLRA. Rieckborn is also significant because it grants nonsettling defendants in Securities Act class actions far broader judgment reduction rights than the PSLRA explicitly provides. In particular, it holds that nonsettling defendants are entitled to know what formula will be used to calculate their judgment reduction at the time of a partial settlement with other defendants instead of making them wait until trial. And it grants nonsettling defendants the right to a judgment reduction measured by the proportionate liability attributable to other defendants for all settled Securities Act claims as opposed to just a dollar-for-dollar judgment reduction. If Rieckborn is more widely adopted, it would provide considerable certainty and settlement bargaining power for defendants. Nonsettling Securities Act defendants would have greater certainty as to the scope of the judgment reduction to which they will be entitled. It would also afford greater protections to nonsettling defendants against low-value partial settlements between plaintiffs and more culpable defendants. This, in turn, would impose substantial pressure on plaintiffs not to agree to such settlements, thus placing settlement dynamics between plaintiffs and nonsettling defendants on a more equal footing. Rieckborn also clarifies the scope of securities class action bar orders in two important respects, thus providing guidance to the drafters of securities class action agreements. It makes clear that bar orders cannot preclude independent claims and instead must be limited to “claims for contribution and indemnity and claims where the injury is the nonsettling defendant’s liability to the plaintiff.” Rieckborn, 2015 WL 468329, at *14. Rieckborn also reaffirms that bar orders must be mutual in the sense that they must prohibit the assertion of claims both by and against released parties. * * * This memorandum is not intended to provide legal advice, and no legal or business decision should be based on its content. Questions concerning issues addressed in this memorandum should be directed to: Susanna M. Buergel (212) 373-3553 firstname.lastname@example.org Charles E. Davidow (202) 223-7380 email@example.com Andrew J. Ehrlich (212) 373-3166 firstname.lastname@example.org Brad S. Karp (212) 373-3316 email@example.com Daniel J. Kramer (212) 373-3020 firstname.lastname@example.org Lorin L. Reisner (212) 373-3250 email@example.com Walter Rieman (212) 373-3260 firstname.lastname@example.org Richard A. Rosen (212) 373-3305 email@example.com Audra J. Soloway (212) 373-3289 firstname.lastname@example.org Associate Gregory Laufer contributed to this client alert.